Stepping on the gas with the price hike

SummaryRIL and partners getting the government’s nod for pricing KG-D6 gas according to the Rangarajan committee formula is the first step towards the roll-out of a pricing mechanism that will fuel exploration

What would be the implications of the government’s nod for notification of the new gas pricing formula?

With the government permitting Reliance Industries Ltd (RIL) to price its gas from the KG-D6 basin as per the Rangarajan committee formula, after the company’s proposal to provide bank guarantee to cover the disputed shortfall in gas production was accepted by the Cabinet, decks have been cleared for the notification of the new gas prices for the industry starting April 1, 2014. This comes as good news for exploration companies like RIL, Oil India Ltd, Oil and Natural Gas Corporation (ONGC) and Cairn India.

How will the Rangarajan formula change gas prices?

India has agreed on a pricing formula for gas supply contracts with producers from April 1, 2014, to replace the present gas prices in the country that range between $4.2 for RIL’s KG-D6 gas and $5.73 for the Panna-Mukta and Tapti (PMT) gas. The domestic gas prices will be determined on a quarterly basis as an average of three major international hub prices (Henry Hub of the US, National Balancing Point of the UK, and the Japanese Crude Cocktail) and the cost of imported LNG into India. The new formula will be valid for five years and applies only to new contracts or renewals when existing ones expire. For the April to June 2013 quarter, the indicative price based on the formula would be $6.83 per million British thermal units (mmBtu). The Rangarajan committee also mentioned that, after five years, “the possibility of pricing based on direct gas-to-gas competition may be assessed.”

What impact will the new prices have on oil companies?

The gas price hike will not be a magic wand that will make all gas exploration in the country viable. However, it will incentivise companies to undertake more exploration, particularly in the on-land and the shallow-water zones, encouraged by higher returns. RIL officials have clearly stated that some of its future deep-water exploration like the Cauvery basin fields will be viable only at free market prices. ONGC officials also say that some of their deep-water fields will be viable with the Rangarajan pricing mechanism, but this might not be the case with all their upcoming exploration projects in the deep- and ultra deep-water zones. A report by IHS-CERA notes that deep-water and ultra deep-water exploration in India will only be viable at gas prices of over $10/mmBtu.